Mathew: Hi, I'm Mathew Warren, Associate Director of the Bank Team and with me today is Jamie Peters, a senior analyst on our team to go over the recent news from Citigroup.
Jamie, so suddenly it looks like they’re going to sell at least a portion of their Smith Barney unit which is probably one of the crowned jewels that they have. Could you walk us through what are some complicated terms that deal with structure?
Jamie: Sure, they’re going to form a joint venture with Morgan Stanley. Morgan Stanley owned 51% of the joint venture. So they co-owned 49% of the joint venture and the city group will be contributing their Smith Barney operations mainly.
Morgan Stanley is contributing a slightly smaller part, their wealth management division. As a result, Morgan Stanley is going to pay city group $2.7 billion upfront for the deal.
Now, over time, this is actually a sale of Smith Barney because Morgan Stanley has the option at the end of year 3 to buy 15% more, the other year for another 15%. At the end of year 5, they find it at final 20%.
So, they will own it potentially by the end of year 5.
Mathew: So, City Group gets to participate in the minority earnings stream for 3-5 and perhaps longer years but they did announce that they’re going to get a large accounting gain from this relative to the value where it is now versus the deal of prices, is that right?
Jamie: Exactly, they’re going to recognize a $9.5 billion pre-tax gain about $6.5 billion and a new acuity capital will be generated as a result of this. That is a very important fact for City Group right now. This company had a very little capital compared to all of the rest that they have on their balance sheet, as a result they had to go the government recently and they got $45 billion from the tart fund in total and this is another way to try to shred up the balance sheet.
Mathew: Okay, so, perhaps helping them out in the short term versus the long term. Looking forward for this new entity, how do you see the competitive landscape you see in Bank America, both Merril’s and their thundering herd and now you have this larger entity that is going to be an awfully large broker units, so how do you see that shipping up going forward?
Jamie: You’re right, the consolidation in the brokerage facet is very interesting and City Group and Morgan Stanley have been saying they’re going to have the largest based on the number of financial advisers. They’re going to have 20,400 advisers. Well, if you add up Bank of America it was 4000 and Merril Lynch’s 16000, you have 20,000 advisers there.
And actually Bank of America and Merril Lynch will have more assets on their management than the Morgan Stanley-City Group deal will have, but that said, we still have one of the largest at things and a very wide mow business.
Costumers tend to be very sticky, they are very profitable, it is a low capital intensive business and that is going to help Morgan Stanley because Morgan Stanley is going to be able to transform itself from just being this eye bank with a midsized brokerage average into having a very large brokerage operations for its business, and that will help stabilize their earning stream.
On the flip side, that means that City Group is giving it up and this is actually one of the few wide mow businesses that City Group seems they still have left. And so, they are sacrificing their long term mow in this for some short term safety.
Mathew: At any, got reaction to what is harvesting this book game, I had a 4th garnering might mean for the quarter, do you expect a tough quarter for city group?
Jamie: City Group is going to have a very tough 4th quarter. We’ve seen so many signs of it and loses could be $10 billion or more.
Mathew: Fair enough. Thanks for helping us sort that out Jamie and thanks for listening.
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